Reducing Frivolous D&O Suits: The “Loser Pays” Proposal

On May, 8, 2014, the Delaware Supreme Court handed down a potentially transformative ruling when it comes to D&O suits. In ATP Tour, Inc. v. Deutscher Tennis Bund, the court ruled in favor of private, non-stock corporation ATP, stating Delaware law does not prevent fee-shifting bylaws.

This means, in appropriate circumstances, a non-stock Delaware company can adopt bylaws (including unilaterally by the board) so that a losing plaintiff who had sued a Delaware non-stock company’s board of directors would be responsible for paying the defendants’ litigation costs.

This could be huge: if a plaintiff has to risk paying not only his own legal fees, but also those of the defendants, that plaintiff will surely tend to file fewer frivolous lawsuits.

You’ll notice that in my description above, I keep using the phrase “non-stock” corporation. The ATP case was about a non-stock corporation (think member-owned association, in this case, a membership corporation that operates a men’s tennis tour). However, the reasoning of the case could be easily applied to stock corporations (i.e., corporations that issue stock to their owners), including public companies.

In its reporting on this story, the Wall Street Journal pointed out that a shareholder owning 1 percent of a company's stock who agrees to be a plaintiff stands to get only 1 percent of any damages awarded in a win for all shareholders, but if unsuccessful would bear 100 percent of the costs.

"What rational plaintiff is going to bring that case?” asked Stuart Grant, who represents shareholders in class actions. “This may be a nice way to eliminate nuisance suits, but the baby's going to go out with the bath water," he told WSJ.

Some speculated that this ruling may pave the way for new bylaws in the more than half of U.S.’s publically traded companies incorporated in Delaware. The law firm Morrison & Foerster concurs, stating, “while typical stock corporations have not adopted fee-shifting bylaws similar to the one at issue in ATP, the ruling may pave the way for adoption and enforcement of similar fee-shifting bylaw provisions.”

Or maybe not, at least not if the Delaware State Bar Association’s Corporation Law council gets its way. It has proposed additions and amendments to the Delaware General Corporation Law (DGCL) that would restrict fee shifting in stock company bylaws, effective August 1, 2014, if passed.

Given that ATP was about a non-stock corporation, why the rush to have the Delaware legislature clarify that the ruling could not be applied to stock corporations?

The answer is, at least in part, because the Delaware court has a history of being open and flexible when it comes to companies using bylaws to structure how internal affairs disputes are to be resolved.

I’m of course alluding to the recent choice of forum win for Chevron and FedEx (in which these two corporations were able to keep their board-adopted choice of forum bylaws.

So, is now the time to change your bylaws to clarify that shareholders who sue the board of directors will be doing so under the “loser pay” rule, rather than the “American (everyone pays their own legal bills) rule”?

Certainly not, until we know the outcome of the proposed ban on fee-shifting legislation.

It is, however, certainly a good time to learn more about the issue. Even though most boards of directors are empowered to change their bylaws unilaterally and without shareholder approval, it would be imprudent to make this type of change without careful consideration, including discussions with counsel on the matter.

Establishing a record of having analyzed the pros and cons before making a change of this significance is also important. Companies that are interested in fee-shifting provisions in their bylaws can start the research and discussion now, while waiting to see whether or not the fee-shifting ban passes.

One more thing: while not dispositive one way or the other, boards will want to consider whether fee shifting could raise red flags with proxy advisory services like the ISS.

Many boards will take the position and argue—vigorously—that reducing frivolous claims brought against Ds and Os is, in fact, in the best interest of shareholders.

Others, however, may take the position that fee shifting inappropriately makes boards less accountable to their shareholders. This latter position will be certainly held by some thoughtful people who are genuinely concerned that shareholders will be disempowered by fee shifting.

Perhaps unfortunately, this latter view will also be held—inevitably—by those lawyers who make a living by bringing frivolous suits against boards in the hopes of a quick payday.

The views expressed in this blog are solely those of the author. This blog should not be taken as insurance or legal advice for your particular situation. Questions? Comments? Concerns? Email: phuskins@woodruffsawyer.com.